7 Ways Captive Insurance Companies Provide a Competitive Edge

From the Spring Consulting Group Team

In recent years, based on their ratings, captive insurance companies have consistently outperformed commercial market insurers. This is based on the balance sheet strength, operating performance, and business profiles of captive insurers as compared to their commercial counterparts.

Captives can play a positive role and are able to provide a competitive edge to the organizations using them. Here are how and why.

1. Homogeneous Risks

Whether a single-parent captive or a risk retention group (RRG), a captive insurance company's insureds will have similar risk profiles and diversity. A single-parent captive insures the parent company, so all its risks belong to one entity. RRGs are made up of like companies with similar missions and business products/services, such as a group of universities. In both cases, the homogeneity of risk will benefit the captive by establishing a certain level of predictability, which helps with the consistency of rates and an unsurprising loss ratio.

2. Underwriting Profit/Results

Captive insurance companies enjoy greater underwriting profits than commercial insurers for a number of reasons, primarily the fact that risk management, control, prevention, and mitigation are all at the heart of the captive's purpose. Organizations are able to benefit from their own good experience. Captives facilitate transparency and more access to data. This allows organizations to act in a proactive manner and implement risk mitigation and control protocols in an almost real time basis. Comparatively, a fully insured commercial market policy may result in a delayed information transition—most commercial insurance arrangements provide reports a quarter after year-end.

3. Return on Investment

A major advantage that organizations with captive insurance companies have over commercial insurers is the opportunity to recuperate part of the premiums. Captives require capital infusion to start and get off the ground. The profits/savings from the insurance company accumulate in the captive and can, over time, begin to yield impressive return on investments. Most feasibility studies use an internal rate of return or a hurdle rate to help visualize potential savings. This makes captives a great alternate for deploying capital and earning a consistently positive return on income, in addition to being able to use it strategically for reinsurance purposes.

Another pro of captives is the ability to evaluate their return on investment through their hurdle rate on their rate of return. A company can determine if an investment will give them adequate benefit or savings over a given time frame based on their rate of return and then decide if that investment is worth following through with or if another solution is more economically sound.

These factors combined allow captives a healthy sum of capital and positive balance sheets.

4. Competitiveness

Commercial insurers are sometimes unable to understand the true needs of the insureds and are limited in their offerings. Captive insurers create competitiveness in the market and can compel commercial insurers to offer better terms. In many instances, commercial insurers are threatened by the captive's ability to take on all the risk and become willing to create quota share arrangements. Captives are a unique, tailored solution for the insured(s) and offer an unbeatable level of customization and very little changes in premiums. They have the ability to insure unique risks and are able to fill in coverage gaps where commercial markets are unable to do so.

5. Enterprise Risk Management

A.M. Best defines "enterprise risk management (ERM)" as "establishing a risk-aware culture and using tools to consistently identify and manage, as well as measure risk and risk correlations." An organization that utilizes a captive insurance company is likely to have a stronger ERM system in place, when compared to its captiveless peers, since it is partaking in its own experience and is more motivated to better manage its own risks. In most cases, the captive is a vital cog in the ERM wheel. This close alignment allows for better results for both parties and a lower total cost of risk for the captive.

6. Retention

Related to but not the same as the aforementioned fourth point, many rated captive insurance companies have a retention rate of 90 percent or higher. This is, in part, because policyholders are routinely rewarded through dividend payments from the captive that are significantly higher than any seen in the commercial market. These profits can be used in multitude ways to further benefit the captive. For example, policyholders could underwrite additional lines of coverage without the need for additional capital, or provide premium holidays on programs, or fund full-time equivalents.

This, combined with the lack of competition, means that captives don't need to shop around for business each year, creating savings in acquisition costs that can, in turn, be fueled into the captive (e.g., in the form of loss control) to further benefit the insureds.

7. Ability To Identify Emerging Risks

A captive’s structure and foundation in ERM gives it an added advantage of foreseeing emerging risks. Typically, all key stakeholders and the entire risk team of an organization will be involved in the captive's management and activity. Having a strong alignment between the parent company, the captive, the IT team, the risk experts, the actuaries, and other main players means that everyone is on the same page. A captive can make long-term assessments while also flagging and resolving issues quickly. There is no fragmentation of knowledge in a captive setup, and all stakeholders have the same interests. In sum, captives allow organizations to be nimble and react to changing market conditions quicker than commercial market insurers.

Conclusion

Captive insurance companies' success is expected to continue. The US captive market has grown substantially over the past few years, with domiciles like North Carolina and Hawaii experiencing an uptick in captive formation. Further, we're seeing captives being used more frequently for nontraditional lines of coverage, such as cyber and medical stop loss, adding to the list of use cases.

We anticipate that captives will continue to grow in popularity and outperform their commercial counterparts. Captives are a great tool for insureds to create unique, custom-made solutions in partnership with the commercial markets. They facilitate better claims management—their expenses and adjustments—through accurate estimations.

Finally, one of a captive's most important attributes is its flexibility and ability to be swift and proactive, without the typical red tape or series of middlemen in a commercial insurance relationship.